Got Debt? Go Ahead, Invest

Yup, you read that right. Even if you owe, put some dough in the market.

No need to clean off your contact lenses or hit "refresh" until an editor swoops in to fix that apparent typo. Your eyes do not deceive. In fact, I'll say it again: You don't have to be totally debt-free before you begin investing.

And here comes the caveat (c'mon, you knew it was coming): You don't have to be totally debt-free before you invest -- as long as you have the right kind of debt.

We all know what the "wrong" kind of debt looks like. It's a wallet-size, hologram-emblazoned temptress powered by a whopping double-digit interest rate. When your bank account turns up its nose at your desires, your trusty credit card says, "Go ahead, I don't mind." Nearly as quickly as the buying high dissipates, the value of all those shiny new goods and services subsides. By the time the real bill -- the one you have to pay, at least in part -- arrives in the mail, you can't even remember why all this stuff was so important to have that you couldn't wait until the next paycheck to buy it.

When is indebtedness ever OK? "OK" debt typically has an interest rate that's less than 10%; some tax advantage; and is due to a purchase whose value increases over time. Think mortgage debt, and even student loans. The first easily fits the criteria: Unless you can afford to plunk down a suitcase full of cash on closing day, bypassing a banking loan is not an option for most. Additionally, homes tend to appreciate over time -- often exceeding the rate at which the interest you pay racks up. And, to add more bloom to the blossom, that interest is usually tax-deductible. (If you haven't already, get to know the tax rules on deducting loan points.)

Student loans are a bit trickier to pass off as "OK" debt. Most education loans carry an interest rate well below 10% (check), preferably locked in at the low rate. And sometimes the interest is tax-deductible (check). As far as fulfilling the appreciation criteria, it can be convincingly argued that increasing one's skill set via schooling is the key to advancement. We applaud the pursuit of higher education -- as do your parents, many employers, and potential mates. (We'll go ahead and give this one a passing checkmark.)

How does this positive spin on debt affect our investing advice? We Fools have long preached the sanctity of investing free and clear of other more pressing financial obligations. But waiting until the house is completely paid off and the burnt mortgage embers cool robs investors of their most powerful tool -- time. (Time, amount invested, and rate of growth are the triple-threat of market-beating returns. Don't take our word for it -- roll up your sleeves and let this simple online calculator prove it.)

Some debt ("good" debt) is inescapable. Putting off investing for your future because of some blanket rule about being debt-free is nearly as dangerous to your future financial health as putting everything on plastic and praying for a carefree retirement.

If you have debt, see whether these rules of thumb help you find an investing plan you can implement:

1. See whether your employer encourages savings through your 401(k) plan. If your boss matches a portion of your contributions, sock away at least as much as necessary to take full advantage of that benefit, as long as you are not overwhelmed by credit card debt. The hundreds of dollars your employer contributes today -- with you just contributing the minimum to get the match -- will be worth thousands after a decade or two of growth. Plus, the money that you contribute comes directly out of your paycheck before Uncle Sam takes a sizable bite. While you watch that money grow, get serious about paying off those cards in the next six months to one year. Again, this strategy is for those with some credit card debt and a clear view of the light at the end of the debt-free tunnel.

2. If you are seriously burdened with credit card debt -- able to cover just the minimum payments or a little more -- put your investing career completely on hold, and pay off your debt. When we talk about being debt-free before investing, credit card debt is where we focus our ire. If your debt carries high interest rates, there is no way invested dollars will be able to outrun what you owe to Mr. Visa. Put all your energy and extra money into wiping it out. Our free "How-To" Guide (.pdf file) will usher you through the steps to paying it off.

3. Still sipping coffee out of your college fraternity mug? Is it because you can't afford a new mug while still paying for the years during which you chugged beer from it? Student loan debt is "OK," so long as it comes with a low rate (5%-ish) that's locked in. Even better is when the interest you pay is deemed tax-deductible. If that describes your loan, then go ahead and start socking away for your future while still paying for your past. Stock up your 401(k) and stuff your IRA until it's full. Vow to apply all future windfalls equally toward your student loan and your discount brokerage account. It takes discipline, but concentrating on building your future while taking care of your past financial obligations will pay off over the long term. If your student loan interest rate more closely resembles what credit card lenders charge, then tackle this debt with all your might before venturing into the stock market beyond your 401(k) minimum investment.

4. Home is where the biggest debt is. As far as "good" debt goes, four walls, a roof, and a welcome mat make a pretty good argument for going into hock. However, from a strictly numbers point of view, you're better off investing in the stock market than putting that same money toward paying down the house. Still, there's a lot to be said for owning your home outright. We don't begrudge anyone who wants to tip the balance sheet in their favor faster than the bank has scheduled -- but the advantages are mostly emotional. (If you're going to devote extra payments to doing so, don't pay extra for a bi-weekly mortgage.) But if paying down the house puts you behind in saving for other goals, then stick to a 12-month mortgage and send the money that would have been the 13th payment to a tax-advantaged account.

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